CIMA BA1 Syllabus B. Microeconomic And Organisational Context Of Business - ROCE - Notes ^{5 / 13}

Return on capital employed (ROCE)

Measuring profit does not give a good measure of how well a firm is performing because it doesn't consider the amount of long-term finance (capital) that has been invested in the firm.

Illustration 1

If a company earns a profit of $100,000

• this would be a good performance if $500,000 had been invested in the company (100,000 / 500,000 x 100 = 20% return)

• but not if $10 million had been invested (100,000 / 10 million x 100 = 1% return).

Measuring capital employed (Capital invested)

Capital is the total amount of long-term finance:

• Long-term debt finance

  - a long-term loan

• Preference Shares

  -  shares that pay a fixed dividend

• Ordinary shares (equity finance)

  - are the owners of the Company
  - these shares do not pay a fixed dividend
  - the dividend they pay can vary from year to year.

Return on capital employed (ROCE)

shows how well a business has generated profit from its long-term financing.

It is expressed in the form of a percentage, and the higher the percentage, the better.

Note:
Profit before interest and tax is called 'Operating profit'.

Illustration

Operating Profit (PBIT) $10,000
LT Liabilities $50,000
Equity $20,000

Required
Calculate ROCE

Solution

ROCE = PBIT / Capital Employed
ROCE = 10,000 / (20,000 + 50,000)
ROCE = 0.14 = 14%

Average Capital employed

The figure for Capital employed is normally averaged out between the beginning and the end of the year.

So, if you are asked to calculate ROCE and you are given 2 years' worth of capital employed figures, you should use an Average Capital employed.
 
However, the ROCE calculation can also be based solely on the value of capital employed at the end of the year, so you will have to read the question to see how to perform the calculation.

Example

Company's financial statements for the years ending 31 December 20X0 and 20X1:

What is the company's return on capital employed (ROCE) for 20X1?

Solution

Average Capital employed is: (500,000 + 465,000) / 2 = 482,500

ROCE = PBIT / Capital employed.

so, for 20X1, this is: 200,000 / 482,500 = 0.41 = 41%